AGL Energy's Path of Shareholder Value (and Environmental) Destruction

1
Trista Rose, Analyst
July 2021

AGL Energy’s Path of Shareholder
Value (and Environmental)
Destruction
How Australia’s Biggest Polluter Destroyed
$12 billion in Shareholder Value
On 1 July 2021, the share price of AGL Energy (“AGL”) hit an almost double-decade
low of A$8.00 after reaching record highs just four years ago. The prolonged and
unrelenting share price fall, which commenced almost immediately following the
departure of former CEO Andy Vesey in 2017, has wiped over 70% of AGL’s market
value to date, and destroyed over A$12bn in shareholder value.

Earlier this year, AGL posted a staggering
A$2.7bn loss1 resulting from write-downs
related to poor risk management on an                   AGL’s share price fall,
early push into windfarms (A$1.9bn), and                 which commenced
increases in the provisions relating to
failure to adequately understand the                     in 2017, has wiped
financial costs of rehabilitating its coal                over 70% of AGL’s
plants (A$1.1bn), which arguably still                  market value to date.
remain grossly inadequate for restoring all
four of AGL’s sites.2

Falls in wholesale electricity prices have undermined AGL’s profitability. However,
AGL’s destruction of $12bn in shareholder value commenced well before this year’s
write downs and the recent power price volatility. A decade of flawed, short-term
cash driven decisions and political interference is more centrally to blame.
Excessive management turnover and no consistent overall strategy aligned with the
scientific consensus on climate risk has also called into question whether
management and the board has really understood what business they are in.

AGL’s Binge on Coal Propels It to Become a World-Leading
Carbon Polluter
Only a decade ago, AGL billed itself as Australia’s “Renewable Energy Leader”.3 As
the carbon pricing scheme was rolling out in Australia between 2010-2012, AGL had

1 AGL Energy. Asset impairment and recognition of onerous contracts. 4 February 2021.
2 On 4 February 2021, AGL Energy recognized charges of $2.686bn in its financial statements for
the period ended 31 December. The charges reflect $1,920m in provisions for onerous contracts
related to legacy wind farm offtake agreements, increases to environmental restoration
provisions of $1,112m, and further impairments of $532m across AGL’s Generation Fleet and
natural gas assets, net of a positive tax effect of $878m.
3 AGL Energy. Annual Report 2011. 26 September 2011. p. 4,

AGL Energy’s Path of Shareholder Value
(and Environmental) Destruction                                                                  2

become the largest individual investor in wind and solar farms, positioning itself as
the dominant provider of renewable energy in the country.

The CEO of the time Michael Fraser, was, at least temporarily, a vocal advocate for
clean energy and the transition to a low carbon economy.4 The company welcomed
the mandatory Renewable Energy Target, which was legislated in 2009, and
announced a pipeline of A$7bn in projects over the following decade to help meet
Australia’s 20% overall renewable energy goals.5

During the 2011 fiscal year however
AGL’s green ambitions faded. Following a
year of low wholesale electricity prices
and excess capacity, the company posted                  During the 2011
weak profits6 and announced it was
shelving its billions of dollars’ worth of              fiscal year, AGL’s
investments in renewable projects7,                  green ambitions faded.
grumbling that the federal government
subsidies for windfarms weren’t
working.8

When the opportunity arose to acquire the Loy Yang A thermal power station and
brown coal mine in 20129, near term profits appear to have prevailed over
principles and AGL went ahead with the deal. The purchase from distressed seller
TEPCO was heavily discounted and included a sweetener of $1bn in carbon credits
from the federal government. As the cheapest generator in the market, Loy Yang in
south-eastern Victoria was expected to produce “substantial future operating cash
flows”10 – in other words, to be AGL’s cash machine.

Loy Yang was (and continues to be) one of Australia’s dirtiest power stations,
emitting over 18.5 million tonnes per year (Mtpa) of greenhouse gases.11 Indeed, as
a result of the acquisition, AGL’s coal power assets now rank the company as the
largest carbon polluter in the country, emitting more than twice that of second-
ranked EnergyAustralia.12

Nevertheless, AGL argued that despite the acquisition, it was still committed to its
position as a renewable energy leader and the cash generated from Loy Yang A

4 AGL Energy. AGL CEO new chair of Clean Energy Council. 16 September 2011.
5 Sydney Morning Herald. AGL to develop renewable energy projects. 23 August 2009.
6 AGL Energy. AGL reports FY2011 profit in line with guidance | AGL. 25 August 2011.
7 The Age. AGL axes wind projects until carbon price approved. 24 February 2011.
8 The Australian. Failed subsidies put AGL wind farm plans up in the air. 24 February 2011.
9 AGL Energy. AGL to acquire Loy Yang A Power Station and adjacent coal mine. 24 February 2012
10 AGL Energy. ASX and Media Release. AGL to acquire Loy Yang A Power Station and adjacent

coal mine. 24 February 2012.
11 Australian Government. Clean Energy Regulator. Loy Yang Power Station and Mine. 28

February 2020.
12 Australian Government. Clean Energy Regulator. 2019-20 published data highlights. 25

February 2021.

AGL Energy’s Path of Shareholder Value
(and Environmental) Destruction                                                                   3

would support its planned investments in renewable opportunities.13

The acquisition of Loy Yang A was a short-term win for shareholders, but also saw
AGL’s commitment to renewables being short-lived.

AGL continued its foray into thermal
generated assets in 2014 with the
purchase of the New South Wales (NSW)
government’s power generating assets,
Macquarie Generation (‘MacGen’) which
included black coal-fired generators
Bayswater and Liddell.14 Desperate to                 AGL’s coal power assets
offload the assets, NSW gave the Liddell
plant to AGL effectively for free.15 Heavily          now rank the company
subsidized long-term contracts for coal                as the largest carbon
supplies also meant that Bayswater and                 polluter in Australia.
Liddell would be the lowest cost baseload
generators in the National Electricity
Market (‘NEM’) covering the eastern
states of Australia, and hence the MacGen
acquisition was immediately earnings per
share (EPS) accretive.

With the rollback of Australia’s carbon tax and the unexpected closure of the
Hazelwood power station in Victoria, the MacGen acquisition was a short-term
success. Following Hazelwood’s closure, wholesale electricity prices rose
significantly across the NEM.16 Due to MacGen’s ability to source coal at extremely
low prices, profits and AGL’s share price soared.

The longer-term problem with AGL’s entire business strategy overhaul, however,
was that its generating asset mix had altered dramatically. By FY15, coal
represented 60% of AGL’s total asset capacity, making the company highly sensitive
to wholesale electricity price fluctuations and dramatically exposed to any global
alignment with the Paris Agreement.

Revenue Mix and the Impact of Wholesale Electricity Prices
With the purchase of the aging 2.2GW Loy Yang A, 2.6GW Bayswater, and 2.0GW
Liddell coal-fired generators, AGL became the largest generator in the NEM

13 Australian Financial Review. Loy Yang numbers stack up for AGL. 25 May 2012.
14 AGL Energy. AGL completes acquisition of Macquarie Generation assets. 2 September 2014.
15 The MacGen assets had a purchase price of A$1.505bn comprising of a coal cost advantage

valued at $768m, Bayswater valued at A$780m, and Liddell valued at $0 representing a “free”
option. AGL. Macquarie Generation Acquisition presentation. 20 August 2014.
16 In Victoria, average spot prices for 2017 were up 85% in 2016 and up 32% in South Australia

for the same period. New South Wales and Queensland were up 63% and 53% respectively.
Australian Energy Regulator. Wholesale electricity prices higher since Hazelwood exit. 29 March
2018.

AGL Energy’s Path of Shareholder Value
(and Environmental) Destruction                                                                    4

accounting for ~20% of the total domestic generation capacity.17 The company
became highly leveraged to thermal generation, and wholesale electricity prices
became the key driver of revenue generation and share price growth.

Figure 1: AGL's Generation Assets FY20

Source: AGL Energy, Bloomberg.

When wholesale electricity prices were high, AGL was able to pass price increases
onto consumers, rake in the profits and pay bumper dividends. In the period
between 2014-2018, average spot electricity prices rose 90% and AGL’s net
earnings comparably rose +65%. AGL’s share price over the same period rocketed
over 80%.18

17 WattClarity. AGL is almost twice as large as the second biggest generator – who’s also in the
list? 10 October 2014.
18 Source: Bloomberg.

AGL Energy’s Path of Shareholder Value
(and Environmental) Destruction                                                        5

Figure 2: AGL’s Share Price Has a 72% Correlation with Wholesale
Electricity Prices

Source: Bloomberg, AEMO.

Similarly, lower wholesale electricity prices have had an inverse effect. Operating
costs are relatively constant with wholesale prices needing to exceed $50-55 per
megawatt hour (MWh) for AGL’s coal generating assets to break even according to
broker, Ord Minnett.19 As there is a much longer lead time for charging customers
higher prices, margins were squeezed and the company was required to absorb
losses.

Since 2014 (when AGL acquired the MacGen assets), the correlation between the
AGL share price and NSW Average Pool Prices has exceeded 70%.20 In the last 18
months, this relationship has decoupled, compounding the downward electricity
price with a laundry list of problems surrounding the company, including
government interference in the closure of Liddell, the enormous write-downs
announced in February 2021 and the impending demerger. Aside from these
extraordinary issues, the relationship between wholesale energy prices and AGL’s
bottom line continues to exist (noting the recent decoupling as wholesale prices
have temporarily spiked on the back of two coal power plant debacles in the NEM).

The aging profile of AGL’s power stations have also weighed on earnings and overall
results. Liddell, due to be retired in 2023, has become increasingly unreliable,
suffering numerous outages which are costly to fix21, and its lack of operational
flexibility means it is consistently unresponsive at times of peak power demand and
hence prices. In 2020 Liddell’s capacity factor was 42%, a sharp decline on the year

19 FN Arena. Cheap Power Very Expensive for AGL, Origin. 8 February 2021.
20 Source: Bloomberg, AEMO, IEEFA Calculations.
21 The Australia Institute. Liddell unreliable, renewables cheaper. 4 April 2018.

AGL Energy’s Path of Shareholder Value
(and Environmental) Destruction                                                                     6

prior where it ran at a capacity of 59%.

Rehabilitation provisions for retirement and remediation of AGL’s power stations
are also a financial expense which have impacted profitability, and the funding of
these provisions will massively undermine AGL’s free cash generation over the
coming decade. For the period ending 31 December 2020, AGL booked a trebling of
the provision for environmental restoration of $1.112bn. The total provision
therefore now stands at $1.394bn for rehabilitation of its four sites (Liddell,
Bayswater, Loy Yang A and the Camden Gas Project).22

Arguably these provisions should have been accounted for over the period for which
they owned them (Loy Yang A was purchased in 2012, MacGen in 2014).

Considering the estimate for rehabilitating the Hazelwood site is expected to exceed
$740m23, AGL’s total rehabilitation provision for the four sites (~$350m per site)
still appears grossly inadequate, posing the risk of environmental damage at each
site and if AGL fails, this leaves the risk with community and taxpayers to pay the
bill.

Figure 3: Generation Capacity by Technology

Source: Australian Energy Regulator (AER). State of the Energy Market 2021. AEMO data.

22 AGL Energy. ASX & Media Release. Asset impairment and recognition of onerous contracts. 4
February 2021.
23 ABC News. Hazelwood rehabilitation estimated to cost $743 million but may rise, Engie says. 20

Jan 2017.

AGL Energy’s Path of Shareholder Value
(and Environmental) Destruction                                                          7

Solar (and Other Renewables) Are Deflationary
Wholesale energy prices have created challenging conditions for AGL’s profitability
in the last few years. Being long aging, inflexible coal-generating assets has
particularly been a problem given the significant changes in the overall generation
mix in Australia since 2017.

Figure 4: Renewable Generation in the National Energy Market

Source: Australian Energy Regulator (AER). State of the Energy Market 2021. AEMO data.

As highlighted in the Australian Energy Regulator’s 2021 State of the Energy Market
report, Australia’s electricity markets are undergoing ‘a profound transformation
from a centralized system of largely fossil fuel generation… towards an array of
smaller scale renewable sources’.24

The proportion of energy generated from renewable sources in the NEM now
represents more than 28.8% of generation25, more than double the proportion of
generation in 2015. Because renewable energy sources have very low running costs
and are able to bid at the lowest price given a zero short run marginal cost of
production, the ‘merit order’ dictates that they get dispatch priority in the bidding
order of national electricity markets, bringing average prices down.

Thanks to the cheap acquisition prices, under-provision of liabilities and coal
subsidies, AGL’s thermal generators traditionally sat near the bottom of the merit
order and initially were better shielded from price fluctuations than the more
expensive coal-fired generators. The tidal wave of new wind and solar
developments however have displaced AGL’s priority in the merit order while also
increasingly placing downward pressure on electricity prices and impacting AGL’s
bottom line.

24   Australian Energy Regulator. State of the energy market 2021. 2 July 2021.
25   Open NEM.

AGL Energy’s Path of Shareholder Value
(and Environmental) Destruction                                                                   8

Earlier this year AGL’s then CEO, Brett Redman suggested the possibility of
“seasonally cycling” or mothballing of its units to manage lulls in demand (and
subsequently profitability).26 As the Australian Financial Review aptly observed,
“The best-case scenario for AGL is that the collapse in electricity prices is cyclical.”27
In July 2021 AGL announced the mothballing of its now uncompetitive outdated
‘baseload’ fossil gas power plant at Torrens B1 in South Australia, building on the
previously announced closure plans of Torrens A, slated for 2022.

AGL’s higher cost, inflexible thermal power plants increasingly can’t compete with
lower cost renewable energy and are being crowded out of the market by subsidized
government supply.28 And the suggestion that electricity prices continue to be
cyclical is unlikely in our opinion.29

Figure 5: New Generation Investment and Plant Withdrawals

Source: Australian Energy Regulator (AER). State of the Energy Market 2021. AEMO data.

Federal government subsidized projects such as NSW’s Snowy Hydro 2.0 and Kurri
Kurri gas, and ambitious renewable energy targets and incentives set by several
state and territory governments would suggest there is no longer a ‘cycle’. Australia
is in a technology-driven transition and electricity prices are likely to continue to
decline as more low-cost renewables and battery capacity are brought online. The

26 AGL Energy. ASX& Media Release. AGL announces intention to create two leading energy
businesses. 30 March 2021.
27 Australian Financial Review. AGL faces an existential crisis. 26 February 2021.
28 Australian Financial Review. 7 July 2021.
29 Recent outages at Yallourn and Callide Power Stations have recently led to an increase in

wholesale electricity prices. Prices are expected to continue to decline due to the influx of
renewable energy, albeit there is likely to be some volatility observed as power stations close
down and outages occur.

AGL Energy’s Path of Shareholder Value
(and Environmental) Destruction                                                               9

companies which are heavily exposed to higher operational cost thermal generating
assets will feel the most pain.

A Series of Short-Sighted Missteps and Strategy Changes,
Plus Excess Turnover in Management
Overexposure to aging and exceptionally high emission thermal generating assets
amidst an energy market transitioning to zero emission sources is arguably at the
heart of AGL’s problems. A series of short-sighted missteps have also weighed on
profitability - inflating and overstating early year profits and failing to inform the
market of the unsustainability of this - really putting into question whether the
management and board have understood the massive technology, financial and
policy risks of the business they operate in.

The whopping $2.7bn write-down which
was announced in early 2021 included a
pre-tax hit of $1.9bn in “onerous
contracts” relating to wind farm off-take
agreements signed between 2006 and
2012. The off-take agreements required
AGL to buy the energy from wind-farms                  The whopping
under long term purchase power                       $2.7bn write-down
agreements (PPAs) at a fixed cost,
believed to be in excess of $100/MWh.30               was announced
Due to the growth in renewable energy,                  in early 2021.
wind energy costs have fallen by more
than 60% since then (an entirely
predictable outcome well before 2021),
resulting in these contracts being
increasingly out of money and AGL
realizing substantial losses.

Eager to increase their retail customer base, in 2015, AGL entered into a
questionable arrangement to acquire Australian Power and Gas Company Limited
(APG). Under the agreement, AGL would acquire APG’s 344,000 customers for a
total consideration of $199m valuing each customer at $562 each.31 This is a
ridiculously large number considering the cost for AGL to acquire a customer had
averaged around $87 that financial year32, particularly in light of the low quality
customer book acquired and the extremely high customer churn rates as consumers
responded to the massive ongoing price escalation and poor customer service.

Over the years, AGL has had numerous strategy changes. Clear focus would have
been difficult due to multiple management changes in the last decade, including four

30 Renew Economy. How AGL lost nearly $2 billion from its early push into wind farms. 4
February 2021.
31 AGL Energy. ASX & Media Release. AGL announces recommended takeover offer for Australian

Power & Gas Company Limited. 15 July 2013.
32 AGL Energy. 2013 Annual Report.

AGL Energy’s Path of Shareholder Value
(and Environmental) Destruction                                                                     10

CEOs with, at times, polarizing ideas at the helm.

Government meddling (which at times looked more like bullying) into extending the
closure of the Liddell Power Station forced management’s hand on various
occasions. The coalition government had been intent on extending the life of Liddell,
even threatening nationalization, despite the beyond-end of technical life and unsafe
working conditions representing more of a liability at this point in time, consistent
with the zero purchase price ascribed to this asset on sale by the NSW government
seven years ago.33

AGL’s plunging share price over the last few
years has now spurred a drastic rethink in
their operations. Following the acquisition
of thermal generators, Loy Yang and
MacGen, AGL saw a temporary booming
valuation and dividends. But the
opportunity to reinvest these unsustainable                    The opportunity
profits and transform AGL into Australia’s
renewable energy leader was squandered.
                                                          to reinvest unsustainable
                                                            profits and transform
Particularly in the past 18 months, the                      AGL into Australia’s
company has been frantically trying to
catch up to Australia’s energy transition,                renewable energy leader
with new renewable projects including the                     was squandered.
enormous distraction of the highly priced
acquisition of Tilt Renewables34, as well as
plans for a pumped hydro facility in the
Hunter Valley in NSW and the acquisition of
two major solar players, Epho and Solgen
Energy Group.

Most recently, the new interim CEO has been trying to sell the idea of a demerger to
shareholders which splits off AGL’s thermal asset base, with desperate attempts to
maintain the company’s credit-worthiness to refinance its debt obligations while
simultaneously funding renewables growth. PrimeCo / New has been structured to
give at least NewCo the opportunity to survive longer term and remain relevant in
the midst of the inevitable global capital market pivot to the decarbonised energy
system of the future, all the while slashing dividend payments for AGL’s embattled
shareholders. Quite a hard sell.

33   Renew Economy. The “Let’s bully and force AGL to sell Liddell” legislation. 5 December 2018.
34   Reuters. Tilt Renewables agrees to $2.1 billion takeover, shares hit record. 15 March 2021.

AGL Energy’s Path of Shareholder Value
(and Environmental) Destruction                                                          11

       About IEEFA
       The Institute for Energy Economics and Financial Analysis (IEEFA) examines
       issues related to energy markets, trends and policies. The Institute’s mission
       is to accelerate the transition to a diverse, sustainable and profitable energy
       economy. www.ieefa.org

       About the Author
       Trista Rose
       Analyst Trista Rose has worked for investment banks in London, New York
       and Sydney and was part of the proprietary trading team at Macquarie bank.
       Trista has degrees from the University of Queensland, University of Oxford
       and is now pursuing a Master’s in Sustainability at University of Sydney.
       trose@ieefa.org